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SINLetter – October 2006

Welcome to edition 15 of the Suria Investment Newsletter (SINLetter), a free monthly newsletter that highlights two publicly traded companies. The objective of this newsletter is to provide you with unbiased initial research and basic facts about individual stocks so that you can then research them further before deciding to add them to your portfolio or not. For those of you who are reading this and are not already subscribed, you can subscribe by going to www.sinletter.com/subscribe.aspx and you will start receiving this newsletter from next month. I have provided relevant links throughout this newsletter, but if you have any questions or comments, feel free to write to me.

What’s New: We have continued tweaking and adding features to our new venture called MustFeed.com and plan to launch it soon. MustFeed is a website that brings together financial information from various blogs and traditional financial websites. MustFeed allows you to narrow down headlines to a specific area of interest such as stocks, ETFs or personal finance and also allows you to search for headlines by stock ticker symbol or name. MustFeed is currently displaying headlines from over 71 contributing blog authors and continues to grow almost on a daily basis. Please feel free to take it for a test drive and let us know how we can make it more useful for you.

September proved to be a tough month for certain stocks in the SINLetter model portfolio with Suntech Power (STP) swinging to a small loss of 0.39% from a gain of 11.84% on August 31st and an additional 26.94% drop in Medifast (MED). Losses in these stocks were offset by gains in Infosys (INFY), Intel (INTC) and VA Software (LNUX), helping the overall model portfolio post a loss of only 0.91%. The monthly and “since inception” performance is tabulated below.

Performance Metric

Dow

S&P 500

Nasdaq

SINLetter

September 2006

2.62%

2.46%

3.42%

-0.91%

Since Inception (Aug 2005)

9.94%

8.13%

2.87%

65.83%

Interest and investment in alternative energy usually spikes when the price of traditional sources of energy like oil and natural gas spikes. The reverse also holds true and falling energy prices in September dragged down alternative energy stocks with them, leading to the modest 0.39% loss in the Chinese solar energy company Suntech Power as mentioned above. Solar energy is currently not competitive with traditional energy sources on the basis of price and is highly subsidized by various governments. Hence if energy prices were to fall further (and I expect them to), there could be continued weakness in the alternative energy sector.

Germany, which has long been one of the biggest adopters of solar energy is beginning to phase out its subsidies. However it is highly unlikely that China or the state of California are going to phase out their subsidies anytime soon. Since China, California and Japan (which eliminated its direct subsidies in 2005) are the key markets for Suntech Power, I expect Suntech to do well in the long-term but with some intermediate-term volatility.

Teva Pharmaceutical (TEVA), which was featured in last month’s SINLetter, dropped 2.74% in September primarily on account of Walmart’s announcement to start offering nearly 300 generic prescription drugs for as low as $4 for a 30 day supply. Analysts who cover generic drug companies claim the Walmart decision will have no impact on generic drug companies in the short-term but there are others who think differently. If Walmart were to expand the number of drugs they offer for this low price, then there may be pressure on generic drug companies as Walmart has a reputation for squeezing the margins of its suppliers. However I do not believe this announcement will have a material impact on Teva for two reasons. According to many experts, generics only cost pennies to make. Secondly, Walmart clearly indicated that these $4 prescriptions would not be a loss leader. If Walmart expects to break even or make a profit on these drugs, the situation cannot be all that dire for generic drug manufactures.

VA Software is once again the top performing stock in the SINLetter model portfolio with a gain of 119.67% since we added it to our portfolio nine months ago. VA Software swung to its first full year of profitability when it released fourth quarter results on August 29, 2006. Even though overall revenue increased more than 25% year-over-year to $10.5 million in the fourth quarter, Wall Street was a little disappointed by VA Software missing its expected revenue number by a mere $0.2 million.

Please note that all the monthly calculations in this section are based on prices from August 31, 2006. The last newsletter was delayed due to the Labor Day weekend holiday and was sent out on September 5th. Prices in that newsletter were as of September 1, 2006.

I am satisfied with the 35.21% returns from Infosys Technologies (INFY) over a four month period (105.63% annualized) and believe that it is now time to take profits off the table. I am also going to sell RCM Technologies (RCMT) and recognize the unfortunate 21.76% loss.

Other Interesting Events:

McDonald’s (MCD) increased its dividend by 49% from 67 cents a share to $1 a share thanks to strength in its core business. I probably did not realize just how appetizing McDonald’s would turn out to be when I said

“An alternative play to Chipotle could be Mc Donald’s (MCD) as it still continues to hold a 69% stake in Chipotle even after the IPO. Mc Donald’s has risen a little over 15% in the last six months but it still looks appetizing at its current valuation with a current P/E of 17.14 and P/S of 2.15.”

The highly leveraged hedge fund Amaranth Advisors lost $5 billion dollars of investor money in a single week in September thanks to some concentrated bets on rising natural gas prices. Another hedge fund, MotherRock, which was into energy trading and lasted less than 2 years, imploded last month. Investors in MotherRock will not receive anything, while Amaranth has suspended redemptions in September and October while it liquidates its positions. Oh the price people pay for highly concentrated bets that go the wrong way. DealBreaker has a good roundup of the Amaranth meltdown.

Most individual investors can borrow about $0.50 for every $1 invested in their brokerage accounts. Amaranth is said to have borrowed $8 for every $1 in assets, a situation very similar to but not as extreme as Long Term Capital Management (LTCM). LTCM was a hedge fund started in 1994 by John Meriwether and included two Nobel prizewinners amongst its founding partners. After some good gains in its first years, the fund imploded in 1998 almost causing a worldwide financial crisis. LTCM has assets of about $5 billion but had placed bets of over $1.25 trillion ($1,250,000,000,000) worldwide. In other words, it had borrowed $250 for every dollar in assets, making the Amaranth leverage appear tame in comparison. I just finished reading a book about LTCM called Inventing Money by Nicholas Dunbar and while the book is very interesting, it is not an easy read. Another book about LTCM called When Genius Failed by Roger Lowenstein may prove to be a better alternative in case you are interested in learning more about the collapse of LTCM.

The long search for a new CEO at Ford Motor (F) finally came to an end with the appointment of Boeing executive Alan Mulally and investors cheered the stock up in response over the next few days. However after Ford decided to scrap its dividend and pushed out their profitability forecast to 2009, the stock retreated and I decided to finally throw in the towel. Even at Friday’s closing price of $8.09, the stock is up 4.79% (without taking dividends into account) since it was featured in the January 2006 edition of SINLetter.

Gold closed the month of September at $598.70, a drop of 4.21% for the month. I am strongly considering adding to my Gold position at these levels either through the exchange traded fund (ETF) streetTracks Gold (GLD) or a gold mining company like Newmont Mining (NEM).

Mattel is a toy company that was launched in Southern California more than half a century ago and is home to some of the most memorable toy brands. If you ever played with a Barbie doll or a Hot Wheels car, you were playing with a Mattel toy. A merger with Fisher-Price in 1993 gave Mattel a strong foothold in infant and preschool toys.

It feels like everyone I know seems to be having a baby these days and almost all of them either already have the Fisher-Price Ocean Wonders Aquarium Swing or have it on their baby shower list. It is this new baby boom that I discussed while featuring Procter & Gamble (PG), along with the release of a new Fisher-Price toy called T.M.X. Elmo that got me interested in Mattel. The T.M.X stands for “Tickle-Me-Extreme” and the X also represents the 10th year anniversary of the hugely popular Tickle Me Elmo, which was launched in 1996 and became the “must have” toy of that holiday season.

The mystery shrouded launch of the T.M.X. Elmo seems to have had the desired effect and according to Toys R Us the toy flew off shelves soon after its September 19th debut. This $40 toy currently sells for as much as $145 on Amazon.com the last time I checked and it is quite possible that it will become the “must have” toy of this holiday season.

A best selling product can do wonders for a small company and sometimes even manages to have a profound impact on the sales of large companies that have multiple product lines. Just think of what the iPod did for Apple (AAPL) or the Razr cell phone did for Motorola (MOT). However the success of Mattel does not depend on just the T.M.X. Elmo. Six out of the top 15 toys in the Toys R Us “Fabulous 15″ list of hot new toys for the 2006 holiday season are Mattel or Fisher-Price toys.

A good company or a great product does not necessarily translate into a great investment. So let’s take a look under the hood of this company (it does make the Hot Wheels line of toy cars) and see what the numbers tell us. At its current Price/Earnings ratio of 13.76, Mattel is attractively priced when compared to the S&P 500 or the toy industry’s average P/E of 24.29. I am also comfortable paying 1.42 times 2005 sales, given the company generates almost half a billion dollars in free cash flow each year thanks to one of the best operating margins in this industry of 12.75%. While the total assets on the balance sheet are almost twice the total liabilities, there are a few things to watch out for. Mattel has almost a billion dollars ($928.39 million to be precise) of debt on its balance sheet, over half a billion dollars in inventory and $728 million in Goodwill. Thankfully it also has $625 million in cash and some of the inventory is most likely a build up for the holiday season.

The stock does seem to have gotten a little ahead of itself with a 24% gain in less than 3 months, but I doubt it is going to pull back a whole lot from these levels given the positive sales outlook for the T.M.X. Elmo. I plan tol purchase Mattel for my personal portfolio after this newsletter is sent to subscribers. With its dividend yield of 2.5%, Mattel could prove to be a good replacement for Marcus (MCS), which I sold last week on valuation concerns.

Competitors:

The toy industry is highly competitive and is often driven by one hit wonders. Mattel faces competition from LeapFrog (LF), JAKK Pacific (JAKK), Hasbro (HAS), the owner of the Playskool and My Little Pony brands and RC2 Corporation (RCRC), which owns the Learning Curve and Lamaze brands. Mattel also faces competition from Nintendo with its November 19th launch of the Nintendo Wii gaming console. The Wii also made the Toys R Us “Fabulous 15″ list of hot new toys.

The Good:

Mattel with its diverse product line, which includes Barbie dolls and Hot Wheels cars, is the number 1 toy maker in the United States.

The Fisher-Price division of Mattel should benefit from the “new baby boom”.

Mattel recently launched the T.M.X. Elmo toy amid a shroud of secrecy and the toy is flying off store shelves.

The company has excellent operating margins and generates almost half a billion dollars in free cash flow each year.

Mattel’s dividend yield of 2.5% is well above the average yield of the S&P 500.

Mattel sports an attractive valuation with a current P/E of 13.76 and a P/S of 1.42.

The stock is showing strong upward momentum in recent months.

The Bad:

The stock has already gained 24% in less than three months.

Mattel carries close to a billion dollars of debt on its balance sheet.

The toy business is highly competitive and usually the “must have” toy of the year tends to come out of the blue.

The pricey Playstation 3 console and the more reasonably priced Nintendo Wii gaming console will be launched this holiday season.

Yes, I realize I am not staying true to my word and streetTRACKS Gold is not a stock but an Exchange Traded Fund (ETF) that as the name implies, tracks the price of Gold. An ETF is like a mutual fund that can be bought or sold from your brokerage account at any time just like a stock. ETFs usually track an index of stocks such as the Dow Jones Industrial Average (DIA) or a commodity like Gold. The expense ratios of ETFs are much lower when compared to most mutual funds. The streetTRACKS Gold ETF allows you to safely and conveniently buy Gold without having to worry about paying a premium for Gold bullion (coins or bars) or trying to store it in a safe place. The key disadvantage of the streetTRACKS Gold ETF from my point of view is that management actually sells the Gold bullion it holds to pay for expenses. The expense ratio of GLD is 0.40%.

I originally decided to pick the chemical companies Dow Chemical (DOW) and DuPont (DD) as a play on the declining price of natural gas. Both Dow and DuPont use a lot of natural gas and even though Dow sports an extremely low P/E of 9.23 and a dividend yield of 3.80%, investors have stayed away from the stock because of high natural gas prices. So the logical conclusion would be that both these companies would benefit from falling natural gas prices. Not so fast. As mentioned above, U.S chemical shipments dropped by 6.2% in the first week of September and the outlook for the economy appears bleak. Chemical companies are cyclical and do not do well in a weak economy. The low P/E for Dow Chemical starts to make sense if you believe that it has reached or is close to the peak of its current cycle.

Having discarded the chemical companies, I decided to feature the health and fitness company Nautilus (NLS) instead. I even did a fair amount of research and wrote up my thoughts on Nautilus. While there were some positive catalysts for Nautilus, I just could not get past the fact that the company had lowered its earnings guidance twice in the last few months. Moreover Nautilus is a retail company that makes the Bowflex line of products and I just do not see people spending hundreds or even thousands of dollars on a home gym if the economy is weak.

Given my outlook and my inability to find another attractive investment, I have decided to allocate about 5% of the model portfolio to Gold given its recent retreat.

Every month we add the two featured stocks into a model portfolio started with a cash position of $100,000 on August 2, 2005. To keep calculations simple, trading costs and regular dividends are not included. Prices reflect the closing price as of the last trading day of the previous month (September 30, 2006 for the October 2006 newsletter).